Newt Gingrich is an Idiot

I haven’t had a chance to follow the back and forth arguments going around right now about possible reforms for this financial crisis, but I can tell you with near certainty that Newt Gingrich’s proposal to suspend mark-to-market accounting practices is just about the dumbest thing I’ve ever heard.

I’m going to really over simplify this for “Dropping Knowledge” purposes:

In accounting, every company is required to file a “balance sheet” to show that its business is in good order. It’s called a balance sheet because your assets should ALWAYS equal your liabilities. Any difference between your assets and your liabilities is covered by shareholders (called owner’s equity).

ASSETS = LIABILITIES + OWNER’S EQUITY

If the value of your assets increase over the value of your liabilities, the value of each owner’s share of the company increases correspondingly.

↑ASSETS = LIABILITIES + ↑OWNER’S EQUITY

If your liabilities are greater than your assets, you need to raise more capital by issuing more shares, decreasing the value of each share.

↓ASSETS = LIABILITIES + ↓OWNER’S EQUITY

The overall value of a company — or it’s “market capitalization” — can be calculated by multiplying all of the shares owned (shares outstanding) by the MARKET DETERMINED PRICE PER SHARE.

MARKET CAP = #SHARES OUTSTANDING x PRICE PER SHARE

If the market thinks you stink, the value of your company drops. It’s pretty simple.

Right now, everybody knows the value of the liabilities. That’s indisputable. You owe what you owe. But nobody knows the value of the assets; or, put more accurately, they know the value depends on the ability of of the underlying mortgages to be paid off.

For the last 18 months, companies have been busy “writing off” losses… basically devaluing their stated assets, so that their balance sheets actually balance. Every time they recognize a loss, the perceived value of the company falls, the stock value drops, as does the market cap– the owner’s equity and asset values drops in correspondence with one another.

Now, financial institutions require capital to perform day-to-day operations. Right now, because banks don’t know the value of their assets, they can’t sell them, and they can’t value the assets (or themselves) as a result. Investors won’t invest, because they don’t believe the write-offs have finished. And nobody will lend to them, because they’re worried the bank will go under at any moment. The rating agencies downgrade their credit worthiness, and the cycle exacerbates.

Newt Gingrich says these liquidity issues rest at the feet of accounting practices requiring the banks to “mark” the price of their assets to their “market” value. If only they could mark to “economic value”… or historical cost, they lending would continue and the crisis of “chasing a rabbit down the hill” could be averted.

Well, let me put it to you this way, Newt:

If I’m a chicken farmer, and all of my chickens die, I’m out inventory. Nobody wants to buy my dead chickens. My company isn’t going to become any more valuable if I’m suddenly allowed to mark my dead chickens at their historical price.